Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model

TLDR

Financial institutions are exposed to macroeconomic fluctuations in the global economy. The study proposes a compact global model to forecast core macroeconomic factors across multiple countries. The model links region‑specific vector error‑correcting equations, estimated for 25 countries in 11 regions with quarterly data from 1979–1999, to produce simultaneous forecasts and analyze interdependencies via generalized impulse responses. Using the model, the authors examined how global risk scenarios affect a bank’s loan portfolio.

Abstract

AbstractFinancial institutions are ultimately exposed to macroeconomic fluctuations in the global economy. This article proposes and builds a compact global model capable of generating forecasts for a core set of macroeconomic factors (or variables) across a number of countries. The model explicitly allows for the interdependencies that exist between national and international factors. Individual region-specific vector error-correcting models are estimated in which the domestic variables are related to corresponding foreign variables constructed exclusively to match the international trade pattern of the country under consideration. The individual country models are then linked in a consistent and cohesive manner to generate forecasts for all of the variables in the world economy simultaneously. The global model is estimated for 25 countries grouped into 11 regions using quarterly data over 1979Q1–1999Q1. The degree of regional interdependencies is investigated via generalized impulse responses where the effects of shocks to a given variable in a given country on the rest of the world are provided. The model is then used to investigate the effects of various global risk scenarios on a bank's loan portfolio.KEY WORDS: Credit loss distributionGlobal interdependenciesGlobal macroeconometric modelingGlobal vector error-correcting modelRisk management